Corruption and Complex Business Rules

This research contributes to our understanding of the interaction between corruption and economic performance by examining the relationship between corruption and business regulations measured in terms of number of procedures, time, and costs that entrepreneurs incur to satisfy government mandates. After controlling for exogenous variables potentially related to corruption and using two-stage least squares methods to mitigate problems associated with endogeneity, we find a robust positive relationship between corruption and complex rules. The findings suggest policy measures aimed at streamlining business regulations to reduce corruption and enhance growth.

JEL Codes: G18, G33, K2, K4, M13

Keywords: Corruption, Complex rules, Cost of doing business

I. Introduction

Corruption, generally defined as the misuse of governmental power for private gain or benefit, is present in every culture, and it is as old as existence norms and legal procedures (Easterly, 2001; Akcay, 2006). The following example clarifies the definition of corruption. If a bureaucrat with discretionary power applies a governmental regulation, this person enjoys a monopoly over the supply of a public good. The public official can deny or approve the application, require additional transactions, order unnecessary inspections, or simply delay the decision on the matter, with the main intention of obtaining personal benefit, generally in the form of commissions or bribes. In effect, the corrupt government employee becomes the owner of a public good that generates rents (Klitgaard, 1988; Shleifer and Vishny, 1993).

Using data from the Doing Business report of the World Bank, this research examines the relationship between corruption and the number of procedures, time involved, and costs paid to start and close a business, register property, and enforce contracts. After controlling for legal origin, ethno-linguistic fractionalization, latitude, and endogeneity, (using two-stage-least squares, 2SLS) we uncover a robust directional channel that goes from more complex business regulations to greater levels of corruption. Moreover, some of the specific components of the procedures, time and costs survived all of the controls, providing valuable information for policymakers to streamline regulations to mitigate corruption and enhance growth.

Our findings are consistent with Tanzi (1998), who contends that direct and indirect factors originate corruption. Examples of direct factors include the existence of regulations, licenses or authorizations, taxes, decisions on government expenditure, and supply of goods and services with prices below market clearing levels, among other discretional decisions. In fact, discretionary power plays a very important role in light of the monopolistic position of the employee described above. On the other hand, indirect factors include quality of bureaucracy, salaries of public employees, penal systems, institutional controls, transparency of rules, laws and processes, and even the example of political leaders.

Our results also support Rose-Ackerman (1996), who posits two reasons for committing bribery: to obtain benefits and to elude costs. The first relates to the government purchase and sale of goods and services, infrastructure supply, and privatizations of companies activities in which potential benefits justify bribery. For example, consider a process of privatization in which many companies wish to participate. Some of these companies do not fulfill requirements to enter, but bribing public employees grants them the opportunity, not only of participating in the bid, but of winning it, even if the final price is inflated or the products' quality is diminished.

The second reason for bribery, to elude costs, is closely related to what we have called complex business rules, paying bribes to circumvent the process. This source of corruption is bigger when a decision depends largely on a public official's discretion or when the norms that rule private economic activities have no clear definitions (Rose-Ackerman, 1996). …

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